vault cash as reserves would correct that inequity. Since vault cash holdings and reserve balances at the Reserve banks both have the same effect in limiting the volume of credit a bank may extend and are interchangeable, it is logical and proper that both be counted as reserves. Doing so would also have collateral advantages: One would be to reduce the costs of transporting and handling currency; another would be to facilitate the holding by member banks of larger stocks of currency that would be available over widely dispersed areas for use in the event of a national emergency.

In the original Federal Reserve Act member banks were permitted to hold somewhat more than half of their required reserves as cash in their own vaults. In 1917 the total reserve requirements were reduced and member banks were required to hold the full amount with Federal Reserve banks. This was a wartime measure designed to mobilize the gold reserves of the country in the Federal Reserve banks. Under the Gold Reserve Act of 1934, all of the country's gold stock is held in the Treasury, which issues gold certificates or gold-certificate credits against most of it to Federal Reserve banks, and the gold stock can be drawn upon only to cover international payments. Thus, there is now no possibility of banks depleting the gold supply by withdrawals to hold as reserves or for other domestic uses, and that reason for not counting banks' vault cash holdings as reserves no longer exists. Taken by itself any withdrawal of currency by a bank either to hold in its vault or to meet customers' demand results in a drain on member bank reserve balances, unless additional reserves are provided by some means. Likewise a return flow of currency adds to the avail ability of reserves. It is for this reason that reserves and vault cash are said to be interchangeable.

Permitting vault cash to count as reserves would release a corresponding amount of reserves now held on deposit at the Reserve banks and thus add approximately $2 billion at a single stroke to the available supply of bank reserves. Unless other action were taken to absorb some of the reserves released, this would increase the lending potential of the banking system by more than a tenth. It would also distort existing differentials in reserve requirements as between classes of banks. Any such change, therefore, would have to be put into effect gradually, and most likely be offset by adjustments in the reserve requirement percentages, as well as by open market operations. When initiating the change, the Board could permit member banks to count as part of their required reserves either all of their vault cash or only a specified portion thereof.

Vault cash holdings vary considerably among individual banks and also vary from time to time for any single bank. Inequities in the present system of reserve requirements arise primarily from the differences among banks in the same class as to their holdings of vault cash. About a fourth of the country member banks, for example, hold cash amounting to more than 5 percent of their net demand deposits, or close to half of their required reserves against such deposits, while another fourth show cash to demand deposit ratios of less than 212 percent. A fourth of the Reserve city banks hold cash amounting to less than 14 percent of demand deposits, with a fourth showing ratios of more than double that figure.

There are wide differences between the reserve classes in their vault cash holdings, but these average differences are more than offset by the differentials in the reserve requirement percentages established for each class. Vault cash holdings and reserve requirements of each class are shown in the table:

Cash in vault of member banks by class of bank, 1st half of February 1959

1 Including requirements of 5 percent against time deposits. Not including requirements against time deposits.

Of the $2 billion of vault cash held by all member banks, in February, about three-fifths, or $114 billion, was held by country banks, whose holdings constitute over 3 percent of their net demand deposits and nearly a fourth of their total required reserves. Vault cash holdings of Reserve city banks as a group amounted to over 111⁄2 percent of demand deposits and 8 percent of required reserves, while the ratios for central Reserve city banks as a group were very small. These average ratios vary somewhat from time to time, but the margins are broadly similar.

These margins of difference in vault cash holdings to some degree compensate for differences in reserve requirements. When vault cash holdings are added to required reserves, the amounts currently tied up by the combination, expressed as ratios to net demand deposits, show much smaller margins of difference between classes than the reserve requirement percentages alone would indicate. While reserve requirements percentages alone would indicate. While reserve requirements on demand deposits alone are 11 percent for country banks, 1612 for Reserve city banks, and 18 for central Reserve city banks, as of February 1959 the combined ratio was 14.3 percent for country banks on the average, 18.1 percent for Reserve city banks, and 18.6 percent for central Reserve banks. In addition to these amounts, member banks have a reserve requirement of 5 percent on time deposits at all classes of member banks.

If vault cash were permitted to be counted as reserves without any alteration of reserve requirement percentages, member banks could reduce their required reserve balances held at the Reserve banks and the margins between classes in such balances needed would be greater than those now in effect. The differences between country banks and Reserve city banks in requirements against net demand deposits would be 512 percentage points (1612 minus 11), as compared with the present margin of less than four points in effective requirements, as measured by the combined total of required reserve balances and average vault cash holdings (18.1 minus 14.3). The difference between coun

try banks and central Reserve city banks would be 7 points (18 minus 11) as compared with a little over 4 points on the average at present (18.6 minus 14.3). As previously stated, some realinement of requirements would be needed in effecting the shift to the new basis.

PERCENTAGE RANGE FOR CENTRAL RESERVE CITY BANKS

By using its legal authority to change requirements for the three broad classifications of member banks, the Board can reduce any undue distinctions between classes of banks.

Under the present law requirements may vary as follows:

The effect of counting vault cash as reserves, as pointed out, would be to lower the amount of reserves required to be held at the Reserve bank. The reduction would be substantial for most country_banks, which now have the lowest reserve requirements, and for some Reserve city banks, but negligible for most central Reserve city banks, which have the highest reserve requirements.

Partly because central Reserve city banks would obtain little benefit from counting vault cash as reserves, the Board is proposing that permissible requirements for central Reserve city banks be lowered to the 10 to 20 percent range authorized for Reserve city banks. No changes are proposed in the permissible limits of the percentage requirements against net demand deposits as now stated in the law for Reserve city and country banks-10 to 20 percent and 7 to 14 percent, respectively.

Another reason for lowering the range for central Reserve city banks is that, in the judgment of the Board, a maximum of 20 percent is believed to provide sufficient leeway for any increases that may be needed in the foreseeable future. With longrun growth in the economy, banks will need to expand credit and the supply of money. Reserves required for this purpose may be provided by reducing requirements gradually in the course of time.

This amendment would retain three classes of banks in recognition of fundamental differences in the character of demand deposits held. The Board could retain higher requirements for central Reserve city banks than for Reserve city banks even though the amendment to the law would establish an identical range of permissible requirements for central Reserve city banks as for Reserve city banks by lowering from 26 percent to 20 percent the maximum and from 13 percent to 10 percent the minimum that could be required of any central Reserve city bank against demand deposits.

No change is recommended in the provision of the law that permits the Board to change reserve requirements within the permissible limits for the different classes of banks. These limits permit a doubling of requirements above the statutory minimum, but the absolute range of variation for demand deposits at central Reserve city banks would

be narrowed from 13 percent to 10 percent. Moreover, the Board would retain authority to reclassify cities, which, together with the other amendment proposed with respect to the classification of individual banks, would make possible adjustments to remove or reduce any inequities between banks or classes of banks.

It has been proposed that the central Reserve city classification be abolished and that there be authority for only two classes of banks Reserve city banks and others. The principal reason advanced for this proposal is that the original basis for the establishment of central Reserve citities is no longer applicable. Under the National Bank Act, central Reserve cities were required to hold larger reserves because deposits with central Reserve city banks could be counted as reserves by other banks; this has not been permitted since 1917. It is also stated that, although banks still maintain substantial balances with central Reserve city banks for operating purposes, the dominance of New York and Chicago in this respect has greatly diminished.

The Board, however, favors the retention of the three classes for a number of fundamental reasons. The proposal to abolish the central Reserve city classification is much more sweeping than the provision in the pending bill to lower the maximum and minimum figures for central Reserve city banks to the same range as that permitted for Reserve city banks.

Practical objections to a mandatory requirement that reserve requirements be made identical for all city banks relate to the problem of absorbing the reserves released and the shifts in established relationships among banks. The change would necessitate either a reduction in central Reserve city requirements or an increase in those for Reserve cities, or both. If requirements at central Reserve city banks were lowered to the present level of Reserve city banks, the effect would have to be absorbed by raising requirements for country banks, if necessary to maintain an appropriate total level of required reserves. If the total level of required reserves were lowered, the additional reserves would need to be absorbed by other means to avoid undue credit expansion. In any event, there would be a realinement of requirements that would alter long-established relationships among banks; the present central Reserve city banks would have lower requirements and country banks would probably have higher requirements relative to the average for all member banks than would be the case if the three-way classification were retained.

Retention of the central Reserve city classification is essential in order to make it possible to deal with any undue concentration of available reserves in money market centers, such as has happened and might arise again in the future. Absorption of such a pool of reserves through open market operations or through a widespread increase in requirements might be impossible without undue effects on other banks having relatively small amounts of reserves available. Such a situation developed in the 1930's when large amounts of both foreign and domestic balances were concentrated in New York, and New York City banks held very large excess reserves. Authority to maintain three classes of banks provides the Federal Reserve with more flexible powers to deal with such variations in the distribution of reserves.

More fundamentally, the Board feels that differentials in requirements among banks are desirable for purposes of effectuating monetary policy. There are fundamental differences in the character of deposits held by different banks and in their impact on the economy. Since the principal function of reserve requirements is to influence the impact of the use of money on the economic situation, such requirements should make allowance not only for the quantity of money outstanding but also for the rate of its use.

These differences are recognized in existing law with respect to requirements against demand and time deposits and to those against demand deposits for the three different classes of banks. They are sufficiently distinct and important to justify three classes of banks rather than only two. Just as there are significant differences between the larger city banks and the smaller country banks which make it appropriate to require different amounts of reserves, there are also differences between large banks concentrated in the leading financial centers and banks in other cities. Differences between large city banks and banks located in small places are numerous and clear. Likewise, New York City and Chicago as banking centers stand out in many respects from other cities. The differences may not be as great as they were in the past, but they are still striking.

As an illustration of these differences, of the 10 largest banks, as measured by total deposits, all but 2 are in New York and in Chicago, and those 2 are statewide branch banks with a substantial volume of deposits at their country branches. Total deposits at all banking offices located within metropolitan areas amount to about $58 billion for New York and nearly $13 billion for Chicago. The next largest are Los Angeles with about $8 billion and San Francisco and Philadelphia with less than $7 billion each.

Interbank demand deposits, which are an indication of the ability of banks to attract funds and put them to work and which have been used in the past as the principal standard of classification, total over $4 billion at central Reserve city banks in New York and $1.2 billion at such banks in Chicago. The largest total held in any other city is less than $500 million. Of the 11 banks holding the largest amount of interbank demand deposits, 10 are central Reserve city banks.

Still another reason for retaining three classes of banks is that large banks in financial centers, which hold the bulk of the more active balances of businesses and investment institutions and also balances of other banks, are in a better position to put available funds to use actively and promptly in the central money markets than are smaller banks or those located elsewhere. Banks outside the financial centers, on the other hand, find it necessary for operating purposes to carry a portion of their secondary reserve assets in the form of balances with other banks, on which they receive no earnings and the carrying of which limits their lending capacity. Even Reserve city banks maintain substantial amounts of balances with other banks, particularly in New York and Chicago. New York banks maintain only negligible balances with other banks and Chicago banks have less than other cities in relation to their balances due to banks. These two cities are central markets for money to an extent that is not true of other large cities.

Typical depositors in large city banks include businesses, individuals, and institutions which have large amounts of funds and use